The RTC credit for increasing research activities provides a dollar for dollar credit against tax liability. The credit can be up to 20% of the excess Qualified Research Expenditures for the taxable year over a base amount. The RTC credit for increasing research activities provides a credit against tax, which is intended to serve as an incentive to you to conduct certain types of product development research activities and certain basic research. (section 41) The credit has been extended (PDF) through June 30, 2004. The credit is an incremental credit equal to the sum of:

Qualified Research Expenditures include wages paid and supplies used in the conduct of qualified research, and 65 percent sub-contractor expenses for qualified research. However an alternate three-tiered research tax credit is available to generate higher research credits for companies with dramatically increasing sales figures or otherwise stagnant research expenditures.

Before taking the credit it is important that you determine that you are: 

• Performing qualified research  
• Claiming expenses only for qualified research.  

Qualified Research Defined

The definition of qualified research contained in section 41(d) provides four tests for determining whether your product development activities, which includes software development, constitute qualified research. Your activity must satisfy all four tests in order to qualify. -  The cost of your activity must be deductible RTC expenditures (IRS Code section 174).   

• The application of the technological information must be intended to be useful in your new or improved business component.

Substantially all of the activities related to your research effort must constitute elements of a process of experimentation.